Personal Loan Management: Budgeting and Planning

Personal loans are a valuable means to finance large purchases and emergencies. Managing your loan effectively can help minimize debt burden and increase financial stability. A good plan empowers you so that you can effectively repay your loan, whereas a lack of proper budgeting can hurt your credit score and create difficult setbacks.

Here is what you should know about budgeting and planning for better personal loan management.

Assessing financial needs

The first step to effectively managing your personal loans is to assess your individual financial needs and goals. First of all, what are the personal loan funds for? If you have a firm grasp of what the loan’s purpose is, it becomes less likely for you to waste any of the funds. The purpose of your loan can help guide your repayment choices and preferences.

After deciding what to do with your loan funds, see what financial obligations you have that might interfere with your debt repayment. Common obligations include:

• Mortgage and rent payments
• Utility bills
• Credit card bills
• Monthly insurance premiums
• Retirement savings
• Emergency fund
• Alimony
• Maintenance fees
• Day-to-day expenses

Listing out your personal financial needs serves as a good starting point in determining your monthly and annual budget.

Loan costs calculation

In order to create a well-structured budget for your personal loan repayment, you will need to be aware of the various costs associated with your loan. When the lender gives you your loan agreement, it should tell you your annual percentage rate (APR), which expresses the total costs of obtaining the loan every year. The APR will take into various components related to your personal loan, such as:

• Your interest rate
• Mortgage origination points
• Discount points
• Lender fees and charges
• Loan processing fee
• Underwriting fee

Loan tenure selection

Selecting your loan tenure is a critical part of planning for your personal loan. Your loan tenure is the period of time between the disbursement of funds and the final repayment date. Here are the main reasons why loan tenure plays such a huge role in your personal loan management.

1. Loan tenure affects your monthly installment

If you opt for a longer loan tenure, it means that you have more time to repay your loan. The monthly installment amount will cost less because the principal loan amount is stretched out over a longer time.

2. Tenure influences your total interest paid

Even though having more time to pay off your loan is typically a good thing since it alleviates your financial burden each month, it also means that you will need to pay more for borrowing money in the long run. Over the stretch of time, more interest accrues, which is why a longer tenure might not always be the best option for you.

3. You should choose a tenure that aligns with your priorities and goals

For the duration of your tenure, you will be in debt. This means making regular, on-time payments toward paying off your loan so that you aren’t penalized for missing payments. If you have other goals you want to prioritize, such as saving up for marriage or an education fund for your child.

Interest rate comparison

Even if you’ve already locked in and signed your loan agreement, it’s still advisable to keep an eye out for the average personal loan interest rate, which fluctuates over time based on market conditions, such as demand and economic growth.

If the average interest rate is significantly lower than your designated interest rate, you may want to refinance your loan. This essentially means trading your current loan for a new one with more favorable terms–in this case, a lower interest rate so that you can save money on interest.

When you’re refinancing a personal loan, make sure that you’re aware of any prepayment penalties. Lenders typically don’t want you to pay off your loan early, because they would be missing out on the interest you would have paid for the full tenure.

If you’ve greatly improved your credit score over time, this might also drive you to refinance your loan or take out a debt consolidation loan with a favorable interest rate. By staying aware of what interest rate you might be able to get from a new personal loan, you might be able to save a significant amount of money in the long run.

EMI calculation

Your Equated Monthly Installment (EMI) is how much you pay your lender every month. It is a fixed amount that is based on your principal loan amount, your interest rate, and your loan tenure. Since it’s fixed, your EMI provides you with a clear idea of how much to budget towards loan repayment every month.

The formula for finding your EMI is:

P x R x (1+R)^N /[(1+R)^N-1]

P = principal loan amount

R = interest rate

N = your loan tenure in months

An EMI calculator can also help you quickly determine your EMI.

If you miss a payment, you will be expected to pay additional interest that will make your next installment cost more.

Debt repayment plan

To simplify your personal loan management, creating a debt repayment plan is a good idea. Your plan should ideally address the following concerns:

• How much do I need to budget for loan repayment every month?
• Will I be able to comfortably afford the EMI, or will it strain my finances?
• Will I make any prepayments to finish paying off the loan faster?
• What non-essential expenses can I cut back on to free up money for debt repayment?
• Is there a particular debt with high interest that I should prioritize?
• Can I boost my income to ease my financial stressors?
• Are there lifestyle sacrifices I’m willing to make to repay my debt sooner?

A financial advisor can also help you determine a realistic budget and strategy for managing your personal loans.

Emergency fund

It’s important to have an emergency fund for when unexpected, costly situations take place. Emergency funds should have enough money to make ends meet so that you can bounce back from the emergency. This typically means stashing away money for 3 to 6 months' worth of expenses.

So what does saving up for an emergency fund mean for personal loan management? The answer depends on whether you already have a substantial emergency fund. If you don’t, then you will need to balance your budget between your emergency savings and personal loan repayment.

Contingency plan

As you learn to manage your personal loan, it’s a good idea to consider contingencies. Strategizing for unexpected circumstances and financial challenges can help you better handle emergencies that might come your way. A contingency plan acts as a financial safety net, which is why it’s so important to create one on top of your basic personal loan management.

In addition to saving up an emergency fund, here are some other contingencies you should keep in mind while making your plans.

1. Insurance coverage

Do you have the necessary insurance coverage? Having insurance can help you deal with unforeseen events in a more manageable way. It mitigates your risks and can protect you financially, allowing you to continue paying off (or get rid of) your debt in case of an emergency.

Here are some types of insurance you might want when you have taken out a loan:

• Loan protection insurance
• Health insurance
• Disability insurance
• Collateral insurance
• Life insurance
• Unemployment insurance

Many insurance companies offer options that help you alleviate your debt payments in case of a covered peril, such as unemployment. If you purchase insurance specifically with debt protection in mind, make sure you clarify and confirm the terms and requirements of the policy to make sure you are adequately covered.

2. Communication with the lender in case of hardship

Keeping an open stream of communication with your lender allows you to apply for loan relief or assistance programs in case you are having trouble repaying your loan in a timely manner. Some lenders are willing to change the terms of your loan if you explain to them what new circumstances you are in and why you cannot make the next loan payment on time.

In general, reaching out proactively before you start missing payments can increase your chances of a successful negotiation with your lender. Options potentially available to borrowers include:

• Temporary payment amount adjustments
• Debt deferment (postponed till a later date)
• Alternative repayment plans

3. Loan restructuring and loan modification

Just because you’ve signed the loan agreement doesn’t necessarily mean that you can’t restructure it to better fit your needs. If you face financial challenges, it might be worth looking into a loan restructuring or modification plan. Similar to communicating to your lender that you need temporary debt relief, requesting loan modification from your lender could greatly ease your situation.

If you successfully restructure your loan and rework your existing loan agreement, here are some potential benefits you could reap:

• Interest rate reduction
• Extended due dates
• Cut your loan balance

4. New contingency budget

An essential part of your personal loan contingency plan is to prepare a new budget in case your finances are restricted. If you plan estimated adjustments to your budget ahead of time, you can save time and stress if the unexpected does occur.

Loan prepayment

Loan prepayment refers to paying off your loan early–either in its entirety or just a portion of it. Some lenders have prepayment penalties, which are typically either a flat fee or a percentage of your outstanding balance.

If you have yet to sign a loan agreement, it’s a good idea to assess your income stability and see how long it might take you to reasonably, comfortably repay the loan. It’s advisable to choose a loan repayment term that suits your budget so that you don’t need to risk prepayment or late payment penalties.

As you plan for paying back your loan, take a look at whether it’s beneficial for you to make extra payments to repay your debt sooner. In some cases, a prepayment can help you save money on interest and reduce your total cost of borrowing.

Financial goals

Your financial goals and aspirations should play a part in your personal loan management as they provide helpful direction and purpose. If you’ve taken out a loan with a longer loan tenure, it can be easy to lose sight of your financial goals if you are not careful. At the same time, if you have clear goals and motivations, it becomes easier to stay on track and repay your debt without missing payments.

Here are the main reasons why financial goals play an important role in personal loan management.

1. Goals provide a good framework for managing your finances and debt

Your financial and life goals can be anything that fits your desires and needs. Common goals include buying a house, starting a business, and paying for higher education. Knowing your goals can not only help you plan more effectively but also ensure that you use your loan funds to achieve meaningful objectives.

2. You can keep an eye out for better options

If your goal is to save money and reduce the overall cost of borrowing, you should know that loan refinancing and restructuring are both valuable options available to borrowers. They allow you to either change your existing loan terms or replace your loan with a more favorable one from a different lender.

If you have multiple sources of debt, loan consolidation can also help you create an enhanced debt management strategy for yourself. Consolidating your debt essentially means taking out a single, larger personal loan in order to combine the rest of your debts into a more manageable one.

3. Goals provide motivation to repay your loan on time

Your goals might include becoming debt-free or freeing up money so you can make investments. Making consistent payments is vital to keeping your credit score up. Missing just a single monthly installment can hurt your credit score and make it more difficult for you to obtain credit extensions or loans in the future.

About The Author

Bryan Huynh

Product Tester & Writer

Bryan Huynh, a committed Product Tester and Writer, ensures that you are well-informed, guiding you in discovering and comparing top-rated financial services, including personal loans, business loans, credit repair, and tax relief.

Articles by Bryan Huynh

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